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On November 14, 2013, the Internal Revenue Service (IRS) issuedfinal regulations that permit employers to suspend or reduce safeharbor nonelective contributions under a 401(k), 401(m), or 403(b)plan during the plan year. The final regulations also revise therequirements that apply to mid-year suspensions or reductions ofsafe harbor matching contributions. The final regulations aregenerally effective for plan amendments adopted after May 18, 2009,while the new requirements that apply to safe harbor matchingcontributions are effective for plan years beginning on or afterJanuary 1, 2015.

Background

Plans maintained under §401(k) and (m) and certain contributionsunder §403(b) plans must meet nondiscrimination and otherrequirements to keep their tax-favored status. This usuallyrequires yearly testing to establish that the benefits providedunder a plan do not discriminate disproportionately in favor ofhighly compensated employees, often referred to as the "ADP test"and the "ACP test." Plans that meet certain safe harborrequirements, however, are not required to perform thesenondiscrimination tests. To satisfy the IRC nondiscrimination safeharbors, an employer must, among other requirements, make eithersafe harbor matching or safe harbor nonelective contributions tothe plan each year on behalf of its non-highly compensatedemployees. Generally, an employer must adopt a safe harborcontribution before the plan year begins and make thesecontributions for the entire year, subject to certainexceptions.

Under the originally issued final regulations, employers couldterminate a safe harbor plan mid-year, or they could suspend orreduce safe harbor matching contributions mid-yearfor any reason if certain other conditions were met. However,employers were not permitted to suspend or reduce safe harbornonelective contributions during a plan year. In2009, the IRS issued proposed regulations allowing employers tosuspend or reduce safe harbor nonelective contributions if theemployer experienced a "substantial business hardship." For thispurpose, a "substantial business hardship" was comparable to asubstantial business hardship under the §412 funding rules. Factorsused to determine whether an employer had suffered a "substantialbusiness hardship" included (i) whether the employer was operatingat an economic loss, (ii) whether there was substantialunemployment or underemployment in the employer's trade orbusiness, (iii) whether the sales and profits of the employer'sindustry were depressed or declining, and (iv) whether it wasreasonable to expect that the plan would only be continued ifrelief was granted.

The final regulations modify the proposed regulations byloosening the standards under which nonelective contributions maybe suspended or reduced, and by imposing new, similar restrictionson the suspension or reduction of safe harbor matchingcontributions.

Summary of New Guidance

The final regulations modify the "substantial business hardship"standard for suspending or reducing safe harbor nonelectivecontributions, replacing that standard with an "operating at aneconomic loss" standard. The economic loss standard is intended tobe more objective and avoid the factual uncertainty of some of the"substantial business hardship" requirements. The finalregulations also allow an employer to suspend or reduce safe harbornonelective contributions for any reason if the employer providesparticipants with notice before the beginning of the plan year thatdiscloses the possibility that contributions may be suspended orreduced during the plan year. This notice must explain thatparticipants will receive a supplemental notice if the suspensionor reduction does occur, and that the suspension or reduction willnot apply until at least 30 days after the supplemental notice isprovided. The following additional conditions, which remainunchanged from the conditions that applied to safe harbor matchingcontributions in the original final regulations, must also bemet:

Employees are given a supplemental notice describing thesuspension or reduction;

The suspension or reduction becomes effective no earlierthan the later of (i) 30 days after the supplemental notice isprovided, or (ii) the date the amendment is adopted;

Employees are given a reasonable opportunity and periodof time before the suspension or reduction takes effect to adjusttheir deferral elections;

The plan is amended to provide that it will satisfy theADP and/or the ACP test, using the current year testing method, forthe full plan year; and

The plan satisfies the safe harbor contributionrequirement through the amendment's effective date.

In order to achieve uniformity between the rules that apply to amid-year suspension or reduction of safe harbor matchingcontributions and a mid-year suspension or reduction of safe harbornonelective contributions, the final regulations also modify therules that apply to mid-year suspensions or reductions of safeharbor matching contributions. Safe harbor matching contributionscan still be suspended or reduced for any reason, but effectiveJanuary 1, 2015, the employer must provide participants with noticebefore the beginning of the plan year which discloses thepossibility that contributions may be suspended or reducedmid-year. Suspensions or reductions as a result of operating at aneconomic loss are also permitted. The additional requirementsdescribed above will continue to apply to a suspension or reductionof matching contributions.

The chart below highlights the main differences before and afterthe new final regulations:

Provision

Before New FinalRegulations

After New FinalRegulations

Mid-year changes to nonelective contributions

Permitted if the employer incurs a substantial businesshardship, as described under § 412(c)(2). Mid-year changes forother reasons not permitted.

Permitted if the employer is operating at an economicloss, as described under §412(c)(2)(A). Permitted for any reason,provided participants receive notice before the beginning of theplan year disclosing the possibility that contributions may besuspended or reduced. Effective for amendments adopted on or afterMay 18, 2009.

Mid-year changes to matching contributions

Permitted for any reason, including economic hardship (norequirement to provide participants notice before the beginning ofthe plan year).

Permitted if the employer is operating at an economicloss, as described under §412(c)(2)(A). Permitted for any reason,provided participants receive notice before the beginning of theplan year disclosing the possibility that contributions may besuspended or reduced. Effective for plan years beginning on orafter January 1, 2015.

For more information, in the Tax Management Portfolios, seeBortz, Mason, and Raish, 358 T.M., Cash or DeferredArrangements xx, and in Tax Practice Series, see ¶5560,Cash or Deferred Arrangements.

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